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Chapter 13: Q 2 Critical thinking question (page 293)

2. Why do you suppose that many economists perceive a trade-off between short-term stabilization benefits of unemployment compensation and a contribution to a higher unemployment rate in the long run?

Short Answer

Expert verified

It is determined that there is a slim possibility that future GDP will be low.

Step by step solution

01

Introduction

The given is the perception of Economists about the trade-off between short term stabilization and a higher unemployment rate

The objective is to explain why the perception is widely spread

02

Step 1 

The existing Social Security system permits retirees to be compensated out of the pockets of current employees. If every dollar they receive is spent solely on consumption, it contributes to GDP.

However, because that dollar is paid by workers in the form of payroll taxes, the GDP shrinks at the same time. As a result, the net effect on GDP is approaching zero dollars.

03

Step 2

If the savings rate falls, the economy's potential GDP will fall in the long run. The economy will contract, and real GDP will likely decline. Still, the long-term growth of the economy is influenced by a variety of factors other than the savings rate.

As a result, the possibilities of a low future GDP are slim.

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Most popular questions from this chapter

Consider the diagram below, in which the current short-run equilibrium is at point A, and answer the questions that follow.

a. What type of gap exists at point A?

b. If the marginal propensity to save equals 0.02, what change in government spending financed by borrowing from the private sector could eliminate the gap identified in part (a)? Explain.

A government is currently operating with an annual budget deficit of \(40 billion. The government has determined that every \)10 billion reduction in the amount it borrows each year would reduce the market interest rate by 0.1 percentage point. Furthermore, it has determined that every 0.1-percentage-point change in the market interest rate generates a change in planned investment expenditures in the opposite direction equal to \(5 billion. The marginal propensity to consume is 0.75. Finally, the government knows that to eliminate an inflationary gap and take into account the resulting change in the price level, it must generate a net leftward shift in the aggregate demand curve equal to \)40 billion. Assuming that there are no direct expenditure offsets to fiscal policy, how much should the government increase taxes? (Hint: How much new private investment spending is induced by each $10 billion decrease in government spending? )

Recall that the Keynesian spending multiplier equals 1 /(1-MPC). Suppose that in panel (a) of Figure 13-1, the government determined that the amount by which the AD curve had to be shifted directly rightward from the point E1 was equal to \(1.0 trillion. If the government decided that a \)0.2 trillion increase in real government spending was required to generate this shift, what must be the value of the MPC?

Every 1-percentage-point increase in the marginal income tax rate induces some workers to supply less labour, which cuts real GDP by \( 0.2 trillion. At the same time, each 1-percentage point increase in the marginal income tax rate causes spendable income to drop, which induces some workers to supply labour that yields \) 0.1 trillion more in real GDP. Is the net outcome consistent with the supply-side theory? Why?

Assume that MPC= 45when answering the following questions.

a. If government expenditures rise by \( 2 billion, by how much will the aggregate expenditure curve shift upward? By how much will equilibrium real GDP per year change?

b. If taxes increase by \) 2 billion, by how much will the aggregate expenditure curve shift downward? By how much will equilibrium real GDP per year change?
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